HB 

/ 11 



SYLLABUS 



OF 



THE PRINCIPLES OF ECONOMICS 



NEW YORK UNIVERSITY 
SCHOOL OF COMMERCE 
ACCOUNTS AND FINANCE 



SYLLABUS 

OF 
THE PRINCIPLES OF ECONOMICS 



NEW YORK UNIVERSITY 
SCHOOL OF COMMERCE 
ACCOUNTS AND FINANCE 



Copyright January, 1915 

By 

JAMES H. LOTT 



m 23 !9!5 

©CI,Ao'94 473 






PRINCIPLES OF ECONOMICS 

CHAPTER PAGE 

I. Development op Economic Thought 4 

II. The Scope of Economics 9 

III. Production of Wealth 12 

IV. Consumption of Wealth 16 

V. Value 20 

VI. Value (concluded) 23 

VII. Money and Credit 28 

VIII. Banking and Exchange 31 

IX. Interest 35 

X. Wages 39 

XL Rent 43 

XIL Profits 47 

XIII. Value, Price and Distribution 50 



CHAPTER I 

Development of Economic Thought 

1. The science of business. 

2. Laws defined. 

3. Ways of obtaining knowledge. 

4. Changes in economic life and thought. 

5. Economic ideas in the ancient world. 

6. The Canonists. 

7. The Mercantile School. 

8. The Physiocrats. 

9. Laissez-Faire School. 

10. The Socialists. 

11. The Historical School. 

12. The Austrian School. 

13. Modern political economy. 

1. Political Economy or Economics is the science of business. 
It seeks to classify and explain the phenomena of the business 
world. Economics is often defined as the science which treats 
of the production, exchange, distribution and consumption of 
wealth. 

2. A law is a rule of action which phenomena follow; it states 
the relation of cause and effect between phenomena. To explain 
anything is to state the law governing its occurrence; the cause of 
any phenomenon is any antecedent which it invariably follows. 

3. There are three ways of obtaining knowledge: intuition, 
deduction and induction. Intuition gives what is sometimes 
called innate knowledge. The mind perceives the truth of some 
things as soon as they are seen. Example: Things which are 
equal to the same thing are equal to each other. 

Deduction is reasoning from the general to the particular. 
Example: All men are mortal; John is a man; hence John is 



mortal. The truth of the first proposition is established by- 
intuition. 

Induction is reasoning from the particular to the general; it 
is getting knowledge by observation or experience. Example: 
If every green apple we try is sour, we conclude that all green 
apples are sour. 

A hypothesis is a scientific guess as to the cause of a phenom- 
enon. If the hypothesis is tested and found to explain all like 
phenomena it is usually called a theory. The theory of economics 
is a statement of the laws which govern or explain the facts of 
business. It is, therefore, made up of many different hypotheses, 
for many different sets of facts must be explained. 

4. Society is progressive. Our great institutions are the prod- 
uct of slow evolution. We cannot hope to understand the 
economic thought of to-day until we have made some study of 
the way in which it has developed. Moreover, the theories of 
the present may be inadequate to explain conditions one hundred 
years hence because new facts may have arisen in the meantime. 
The student of economics -must realize in the beginning that 
conditions are constantly changing and that new theories must 
therefore be developed from time to time. 

5. Economics was not studied by the Greeks and Romans. 
They despised business; hence their philosophers were under no 
inducements to explain its phenomena. They believed in slavery 
and Aristotle once described the slave as an "animated tool." 
Slavery made it possible for the higher classes to perfect them- 
selves in statecraft and the arts. Interest taking was condemned 
on the ground that money is barren. The Romans encouraged 
agriculture. 

The Christians objected to slavery and insisted upon the 
honorableness of toil and the equality of all men before God. 

6. The thought of the Middle Ages was dominated by the 
Catholic Church. The philosophers of the church, or Canonists, 
took from the Bible injunctions against usury and the pursuit of 
wealth. Communism, even, was favored by some. Trade was 
considered inferior to agriculture and handiwork. To charge 
more than a just price was a sin, the just price being enough to 
enable the producer to maintain his standard of living. When it 



6 

was seen that interest taking could not be stopped, a maximum 
rate was fixed by law. 

7. The Mercantile ideas prevailed from the early part of the 
sixteenth until late in the eighteenth century and their influence 
is still felt. The Mercantilists assumed that gold and silver were 
the most important commodities and that a nation's wealth 
could be increased best by enlarging its store of these metals. 
Consequently they advocated duties on imports and bounties on 
exports, in order that a so-called favorable balance of trade might 
result. If exports were made to exceed imports the balance 
would have to be paid in gold and silver. Such statesmen as 
Colbert in France, Frederick the Great in Prussia, and Cromwell 
in England, belonged to this school. A typical book of the time 
is Thomas Mun's "England's Treasure by Forraign Trade." 
The Mercantilists held that the government should interfere with 
and regulate business in every way in order to bring about the 
results which they considered desirable. 

8. The influx of metals from America in the seventeenth 
century lowered their value and so caused a great rise in prices. 
Man's attention now was centered more upon the other necessities 
of life than upon the precious metals. Commodities, because of 
their rising prices, seemed to be growing scarcer. 

Out of this condition grew the school of economists known as 
Physiocrats. They were mostly Frenchmen, Quesnay being the 
most prominent. They held that nature was the sole source 
of wealth and that a nation should encourage agriculture rather 
than foreign trade or manufactures. They thought that all 
taxes should be levied directly upon the land since they must 
ultimately fall there anyhow, land being, in their opinion, the 
only source of wealth. 

9. The Laissez-Faire School, or Enghsh Classical School, was 
founded by Adam Smith, a Scotch professor of Moral Philosophy. 
His "Wealth of Nations," published in 1776, was the first sci- 
entific and orderly discussion of all the important phenomena 
connected with business. Adam Smith is therefore often called 
the father of political economy. He combats the doctrines of 
the Mercantilists and some of those of the Physiocrats, although 
he was influenced by the latter. He held that the government 



should not interfere with business, that all men should be left 
free to follow the vocations for which they are best fitted, and that 
no industry should be stimulated by protective tariffs or any form 
of government interference. His book revolutionized economic 
thought in England and finally brought about the adoption of 
free trade. 

Other prominent English writers who agree in the main with 
Adam Smith were Thomas Malthus, noted for his discussion of 
the tendency of population to increase faster than the means of 
subsistence; David Ricardo, noted for his theory of rent and his 
clear views upon financial questions; and John Stuart Mill, 
whose "Principles of Political Economy," published about 1850, 
put into one system the views of the preceding writers. The 
writers of the Laissez-Faire School are criticised for their exces- 
sive use of deduction and are, on that account, called ultra- 
theoretical. 

Mill broke away, somewhat from the idea of laissez-faire and 
advocated state regulation and taxation of inheritances. He also 
recommended the unearned increment tax as another corrective 
of the evils of the existing system of distribution. He was in- 
fluenced by the early Socialists. 

10. Socialism was a strong protest against the doctrine of 
laissez-faire, the backbone of which is unfettered private owner- 
ship of the means of production. Prominent among the early 
Socialists were Godwin, Cabet, Saint-Simon, Fourier, etc. Karl 
Marx, in his "Capital," violently attacked the established insti- 
tutions, especially private ownership of capital. The influence 
of Socialism has steadily increased since the time of Marx. 

11. In reaction from the deductive methods of the English 
economists the Germans went to the other extreme during the 
last century and endeavored to build up the science of economics 
by the study of actual facts and conditions. Poscher and 
Schmoller are the best known writers of this group, known as the 
Historical School. 

12. The Austrian School objects not so much to the methods of 
the Classicists as to their conclusions. It contributed the marginal 
utility theory of value. It revolutionized economic thinking, giv- 
ing the consumer the center of the stage instead of the producer. 



Menger, Wieser and Bohm-Bawerk are the leaders among the 
Austrians. 

13. Modern economists are endeavoring to combine the 
advantages of deduction and induction. It is recognized that 
facts cannot be explained by men who are not acquainted with 
them, hence that deductions based upon hypothetical or imaginary 
conditions must be avoided as far as possible. 

References 

E. R. A. Seligman, Principles of Economics, Chapter 8. 

Richard T. Ely, Outlines of Economics, Chapter 36. 

Charles Gide, Political Economy, Chapter 2 of Introductions. 

L. H. Haney, History of Economic Thought. 

J. K. Ingram, History of Political Economy. 

L. L, Price, History of Political Economy in England. 

E. Cannan, History of Theories of Production and Distribution. 

G. SchmoUer, The Mercantihst System. 

R. H. I. Palgrave, Dictionary of Pohtical Economy. 



CHAPTER II 

The Scope of Economics 

14. Definition and scope of economics. 

15. The aims of business. 

16. Relation of economics to other subjects. 

17. Material goods and services. 

a — Utility. 

b — Free and economic goods. 

18. Value. 

a — Value in use. 

b — Value in exchange. 

19. Price. 

20. Wealth. 

21. Income. 

22. Production. 

23. Consumption. 

24. Capital. 

25. Principal divisions of economics. 

14. Economics is the science of business. Its aim is to collect 
and classify the facts of the business world and to explain them. 

15. In the modern world business is being placed more and 
more upon a scientific basis. 

Business denotes all those activities in which men engage 
in order to secure the means of satisfying their wants. Men are 
prompted to engage in business by various motives. The need 
for food, clothing and shelter is the primary motive. Besides 
this there is the love of wealth, power, distinction and the desire 
to render service to mankind, etc. 

16. In this course we deal only with the broad and elementary 
principles of economics. The science is rich and varied, includ- 
ing within its scope some of the most vital problems of society 
and calling to its assistance the best results of all scientific study 
and of all human endeavor. It takes from psychology its analysis 



10 

of human wants; it draws also upon the physical sciences and 
upon politics, ethics and law. 

17. Goods, or commodities, have been commonly divided into 
two classes: (1) Material goods, such as books, food, etc.; and 
(2) immaterial goods or personal service, such as the advice of a 
physician or lawyer. 

Utility is that property of an object by virtue of which it 
satisfies human want. 

If no sacrifice or effort is required to obtain an object, it is 
called a free good; an object, which can be obtained only through 
effort or sacrifice, is an economic good. Most goods are in the 
latter class. Free goods are few in a densely populated district. 
Even air becomes an economic good in the buildings and sub- 
ways of a crowded city. In the study of economics, free goods are 
of no concern. 

18. Economic goods are said to have value. If a thing is 
destined to immediate consumption it has "value in use" to the 
consumer; if it is to be exchanged for some other thing, it has 
* ' value in exchange . " " Value in use ' ' depends upon the attitude 
of the consumer; "value in exchange" depends upon the attitudes 
of both the buyer and the seller. The term "value" is usually 
employed in the latter sense. 

Value in exchange is the ratio at which one commodity ex- 
changes for other commodities — its purchasing power over other 
things. 

19. Price is the amount of money a thing exchanges for. 
Utility, value and price are not intrinsic qualities. They are 

not inherent in a commodity, but are derived from human esti- 
mation. 

20. Wealth is the total stock of economic goods and services. 
The wealth of an individual is the goods and services to which he 
has a valuable claim. Wealth is measured in terms of value or 
price. Utility and scarcity are essential before a commodity can 
be considered as wealth. 

21. Income is the new wealth accruing to society. It may 
be measured in terms of money or in terms of the satisfaction 
derived. The first is sometimes called "money income"; the 
second "psychic income." 



11 

22. Production is the process of creating means by which 
human wants are satisfied. It has been defined as the creation 
of new utilities. 

23. The process of satisfying human wants is consumption. 

24. Capital is produced wealth, used in producing new wealth. 
Capital is of two kinds: (1) capital goods and (2) loanable funds. 
Capital goods are those goods actually used in the productive 
processes, such as raw material, machinery and the means of sub- 
sistence. Loanable funds are purchasing power over goods. 
They may take the form of money or of credit. Capital, like 
wealth, is measured in terms of money. 

25. Economics is divided into four principal divisions: (1) 
production, (2) exchange, (3) distribution and (4) consumption 
of wealth. 

References 

Seager, Principles of Economics, Chapter 4. 
Taussig, Principles of Economics, Chapter 1. 
Ely, Outlines of Economics, Chapters 1 and 7. 
Seligman, Principles of Economics, Chapters 1 and 2. 
Gide, Political Economy, Chapter 1 of Introduction. 
Keyner, The Scope and Method of Economics. 



CHAPTER III 

Production of Wealth 

26. Nature of production. 

27. Factors in production. 

28. Nature. 

29. Labor. 

30. Capital. 

31. Entreprenuer. 

32. Cost and expense of production. 

33. Decreasing and increasing cost of production. 

34. Coordination of factors. 

35. Division of labor. 

36. Forms of business organization. 

37. Large-scale production. 

26. Production is the process of creating means by which man's 
wants may be satisfied. This does not mean the creation of new 
material; the productive agent merely gives new properties to 
the material in hand. The making of a watchspring from a piece 
of iron — a painting from various daubs of paint — is a process of 
production. A worthless object may be transformed into an 
object of value by educating people to appreciate it. A mush- 
room, in one country, is a weed; in another, a delicacy. 

27. From the earliest economists three factors have always 
been distinguished in production: land, labor and capital. 

These are not on an equal footing. Labor is the only one that 
can claim the title of agent of production. Man alone takes an 
active part. Nature plays a passive part but is none the less 
essential. Men can not work on nothing. Capital, like nature, 
plays a purely passive part; but, unlike nature, capital can not 
be called a primary factor in production. Chronologically, nature 
at first produced alone. Then labor joined with nature; and, 
finally, capital, the product, appeared for use as a tool. Some- 
times it is impossible to separate the three to-day, so complex has 



13 

industry become. In the production of one thing, nature plays 
the most important part; of another, labor is the important fac- 
tor; and, of another, capital is predominant. 

28. In the process of production nature furnishes a suitable 
environment, raw materials, and motive forces. Climate has 
exerted a decisive influence upon the development of the different 
races. Fertile lands have made one people rich while another, 
doomed to labor on shallow soils and rocky hills, has remained in 
poverty and comparative barbarism. Beds of ore and coal, 
steam, waterfalls and electricity — who can say how much these 
have contributed to modern industrial development? 

29. Labor works matter into new form, thus making possible 
new utilities. Labor denotes human activities. It is different 
from material goods because it is associated with a personality. 
Certain personal qualities increase the productivity of labor. 
Some of these qualities are intelligence, judgment, energy, ambi- 
tion, perseverance, imagination, ingenuity, technical knowledge 
and skill, health, etc. Three different aspects of labor should be 
distinguished: (1) manual labor, (2) the labor of invention, and 
(3) the labor of supervision. 

30. With naked hands man can produce little from nature. 
The tools, which he uses in the production of further wealth, are 
capital. Capital is, itself, produced — perhaps by nature, or by 
labor, or even by capital. Unusual is the joint product of all 
three. New York's water supply is made possible by the use 
of capital. Without capital it would be necessary for every man 
to go to the nearest stream and dip water with his own hands. 
Such a condition is now inconceivable. We are constantly using 
wealth, which has been produced and saved, in the production of 
further wealth. So important is capital in production to-day 
that this is often called the age of capitalism. 

31. The men who plan new enterprises and manage them are 
sometimes set aside as a fourth factor in production. They are 
called entrepreneurs and are generally classed with labor. It 
makes no difference where the entrepreneur is classed so long as 
his function is understood. 

Some claim that labor is the sole source of wealth. They say 
that nature produces nothing that is absolutely ready for use. 



14 

This cannot be admitted. Even if it were true, the fact would 
still remain that nature does much toward the production of 
many articles of common use. These people admit that capital 
to-day plays a part in production, but point out that all our capi- 
tal is the result of labor. It is true that all our capital goods can 
be traced back either to land or labor in the last analysis. In 
fact, as was said above, capital may be considered as a 
secondary factor. The fact that capital is secondary in time 
does not make it any the less important in the practical opera- 
tions of to-day. 

32. A distinction is often made between cost of production and 
expense of production. By the former is meant the sum of the 
efforts and sacrifices involved in production. These are psycho- 
logical or subjective. By expense of production is meant the 
"advances made for materials, labor and all other things" 
involved in the productive process. Expenses are measured in 
terms of money. 

33. Some articles are manufactured under conditions of 
decreasing cost. That is the cost per unit of producing a large 
supply is less than that of producing a small supply. The auto- 
mobile industry is an example of this. Some articles are pro- 
duced under conditions of increasing cost or of diminishing 
returns. Wheat raising is an example of this. It costs more per 
bushel to raise sixty bushels of wheat on a given acre of land than 
it does to raise twenty bushels. It is sometimes said that manu- 
facturing industries operate under decreasing costs, while agri- 
cultural industries operate under increasing costs. This is not 
absolutely true but there is a tendency in this direction. 

34. It is important that the factors of production be properly 
coordinated in each industry. The productive forces must then 
be coordinated with the forces of exchange and distribution. 
Coordination is the big problem of business management. 
Scientific management attempts to bring labor to the high state 
of efiiciency already attained by machinery. Farmers often 
speak of a neighbor as being "land poor." A farmer with a 
small supply of labor and capital does not need a big farm. 

35. A characteristic feature of modern business organization 
is division of labor. There are different kinds of division of 



15 

labor: (1) separation of occupations: (2) subdivision of tasks in 
each employment: (3) separation of territory, etc. 

Division of labor has certain advantages. There is a gain in 
time and in skill. Both labor and capital are used more advan- 
tageously. The use of machinery is encouraged. To offset these 
advantages, some think that the worker is forced down in the 
scale of society. He becomes a cog in a machine, without initia- 
tive. There is much truth in this contention. 

36. There are three chief types of business organization, as 
follows: (1) individual, (2) partnership, and (3) corporation. 
Each has its advantages and disadvantages. The modern 
development is toward the corporate form. Some advantages of 
the corporation are: (1) continuity, (2) large capital, (3) flexi- 
bility, (4) limited liability, and (5) ability to command executive 
talent. The great disadvantages are diffused responsibility and 
the necessity for dependence upon a single individual as manager, 
whose personal fortune may not be involved. 

37. One of the advantages possessed by corporations is large- 
scale production. This makes possible, among other things, a 
greater division of labor, cheaper capital and supplies, saving in 
by-products and elimination of cross freights. 

References 

Seager, Chapter 8-10. 
Taussig, Chapter 2-7. 
Ely, Chapter 9-10. 
Seligman, Chapter 18-22. 
Gide, Book 1. 

Charles Babbage, On the Economy of Machinery and Manu- 
factures. 
Biicher, Industrial Evolution. 
Bohm-Bawork The Position Theory of Capital. 
T. B. Veblen, The Theory of Business Enterprises. 



CHAPTER IV 

Consumption of Wealth 

38. Definition of consumption. 

39. Productive and final consumption. 

40. Human wants. 

41. The consuming power of society unlimited. 

42. Wants differ in intensity. 

43. Law of diminishing utility. 

44. Present and future goods. 

45. Complementary wants. 

46. Effect of social standards. 

47. Habit and heredity. 

48. Definition of demand. 

49. Elasticity of demand. 

50. Necessities. 

51. Luxuries. 

38. Consumption, in economics, means the satisfying of human 
wants. It treats of the relation of human wants and the means 
for gratifying them. In this connection, then, we are concerned 
with the nature of human wants and with the nature of goods. 

39. Final consumption refers to the use of wealth only for the 
immediate satisfaction of wants. Productive consumption refers 
to the using up of wealth in the production of other goods. In 
individual cases the two are often mingled. Does the laborer eat 
in order that he may satisfy desire or in order that he may gain 
strength for further labor? 

40. Man's wants are the motive force of all economic activity. 
They have various characteristics, each of which is of great 
importance, for on each are based many of the economic activities 
of mankind. 

41. Man's wants are unlimited in number. This is the main- 
spring of civilization. To civilize a people is no more than to 
arouse new wants within it. New wants are sure to rise as fast 
as old ones are satisfied. The essence of real progress is the sub- 



17 

stitution of nobler wants for the ones already developed. "Woe 
to the races too easily satisfied, whose desires do not reach beyond 
the narrow circle of a near horizon, and who ask but a handful of 
ripe fruit to live on, and a wall to shade them from the sun when 
they sleep!" 

42. Want for a single thing is limited in capacity. This is 
important for upon it a new theory of value is based. Man 
needs only a certain amount of bread to still his hunger, a certain 
quantity of water to quench his thirst, and a certain amount of 
music and painting, etc., to satisfy his desire for art. The more 
elemental or physiological a want is, the more definite is its 
limit. The pangs of thirst are one of the bitterest torments 
known; but one of the cruelest tortures of the Middle Ages, the 
"water torture," consisted in forcing water into the victim's 
stomach. 

43. The law of diminishing utility is derived from the fact that 
particular wants are limited. While all the wants of an individual 
or of society may never be satisfied, any particular want is sub- 
ject to gradual diminution and may be finally satisfied if con- 
sumption continues. The last unit of the supply consumed is 
called the marginal unit. This characteristic has been stated in 
the form of a law, known as the law of diminishing utility, thus: 
The utility of each successive unit of supply consumed is less than 
that of the preceding unit. This is only a general proposition. 
The fourth glass of champagne may be more eagerly sought 
after than any of the preceding glasses. 

44. Present consumption is preferred to future consumption. 
People live much in the present and are bent on satisfying their 
immediate desires. As man rises in the scale of civilization he 
looks more and more into the future. He begins to deny present 
wants in order to provide for a greater need that is seen ahead. 
Yet, man always discounts the importance of future needs. 
This characteristic causes men to demand a reward for post- 
poning the enjoyment of wealth; it partially accounts for the 
payment of interest. 

45. Wants are complementary. A carriage calls for a horse; a 
motor car, for tires, etc. Wants generally go together and can 
hardly be satisfied separately. 



18 

46. Wants are greatly influenced by social standards. Custom 
helps man to decide upon his dwelling, his food, his clothing, his 
business, his amusements, and his every action. 

47. Wants, once satisfied, tend to recur, to become fixed and 
to pass into habits. This fact is of special importance in the wage 
question where the standard of living enters. It is claimed by 
some that a habit which prevails through long generations tends 
to become hereditary. If true, this statement is of inestimable 
significance. 

48. Demand means effective desire — desire backed by ability 
and willingness to pay the current price for the thing wanted. 
Potential demand is desire backed by ability and willingness to 
pay something below the current price. Potential demand 
becomes real demand as the current price is lowered. Increased 
purchasing power adds to .the wants of individuals, as well as to 
their demands, by opening up new possibilities never dreamed of 
before. 

49. The demand for one object may fall much more rapidly, 
as its supply increases, than the demand for another object under 
similar conditions. If demand changes quickly to meet differing 
conditions it is said to be elastic. Two persons, who put the 
same estimate upon a first apple, may differ widely in their 
estimates on a second. The social demand for apples is a com- 
posite of all individual demands. 

50. Necessities, in economics, denote not only the food, cloth- 
ing, and shelter indispensable to life, but, in addition, all those 
things which each individual considers requisite to his industrial 
efficiency. 

51. All economic goods, which are not necessities, are luxuries. 
Evidently a thing which is a necessity to one man may be a luxury 
to another. It is desirable that all should be supplied with their 
necessities before any begin the use of luxuries. 

The Grand Monarch sought to justify expenditure for luxuries 
on the ground that it provided employment for the poor. Econ- 
omists have easily exploded this argument by showing the funds 
could have been more efficiently expended elsewhere, if the object 
sought was the highest social good. 



19 

References 
Seager, Chapter 5. 
Ely, Chapter 8. 
Gide, Pages 35-40; 693-703. 

Patten, The Consumption of Wealth and Dynamic Economics. 
Mayo-Smith, Statistics and Economics, Book 1, Chapter 2. 
Chapin, The Standard of Living among Workingmen's Families 

in New York City. 
Streightoff, The Standard of Living. 
Eighteenth Annual Report of the United States Bureau of Labor 

(1903) on Cost of Living and the Retail Prices of Food. 



CHAPTER V 

Value 

52. The problem. 

53. Value and price. 

54. Three theories of value. 

55. The trader's theory. ^ 

56. Goods produced for sale. 

57. Effective and potential supply. 

58. Corollaries. 

52. The problem now is to explain the ratio at which goods 
exchange in the markets. Why do some goods have large pur- 
chasing power and others small? 

53. It is well to keep clear the distinction between value and 
price. The terms are sometimes used as if they were synonyms. 
Students must bear in mind, however, that this is not the case. 
The price of wheat, for example, may change when the value of 
wheat does not change. The average value of goods can never 
change; the average price will be changed by a mere change in 
the value of one commodity— money. We are now talking about 
value in exchange. 

54. The subject of value may be looked at from three points of 
view and as a result we get what may be called three theories of 
value. These three theories, however, are merely different ways 
of looking at the same phenomenon. Taken together they con- 
stitute one complete theory or explanation of value. 

55. The trader's theory of value is derived from observation and 
it may also be called the observer's theory. Briefly stated it is 
as follows: 

. Value is such a ratio of exchange as tends to establish an equation 
between demand and supply. 

By demand is meant the quantity of goods which people are 
willing to buy at a given price; by supply is meant the quantity 
which they are willing to sell at that price. 



21 

56. This theory presupposes that all goods are made to be 
sold, and must be sold. The assumption is approximately true 
for several reasons. Chief of these is the division of labor. 
Men no longer produce the things which they consume. The 
man who works in a nail factory buys even the nails for his own 
house and sells his labor. This proposition is especially true in 
crowded communities. Secondly, every good has a certain 
economic life. Some goods are highly perishable. They must 
be sold before they perish on the hands of the producer. Finally, 
even if goods were not perishable they would have to be sold so 
that the producer could get back his capital for use in further 
production or in payment of debts already contracted. If goods 
are not sold producers must go out of business. The small 
quantity of goods produced for consumption by producers may 
be ignored for our purposes. 

57. It is well to make the distinction between effective and 
potential supply as we have already done in the case of demand. 
The effective supply is the quantity offered at the current market 
price. The supply intended for sale but held for a higher price 
is called the potential supply. The two combined constitute 
the total stock on hand, sometimes called in trade the visible 
supply. 

Assuming that goods must be sold, it is evident that producers 
cannot long ask a price above that which consumers are willing to 
pay. Hence, when the supply of a given commodity is greater 
than the demand (at the market value) the value must fall. On 
the other hand, if demand is greater than supply, competition 
among buyers will force the value up. Thus the value of any- 
thing is always tending toward that figure which makes the 
demand absorb all the supply on the market. 

The trader's theory may be stated in a different way: The 
value of any commodity is determined by the interaction of 
supply and demand. 

It is important to note that both supply and demand operate 
to determine value. Both blades of scissors must work together 
to cut. One may be stationary but it is operative just the same. 
So it is with demand and supply in the fixing of value. 



22 

To say that demand and supply control value is almost a 
platitude. It is necessary to go back of the statement in actual 
practice and examine the forces affecting demand on the one side 
and supply on the other. Two theories of value have been con- 
structed — one looking only at demand, the other looking only at 
supply. An examination of them will give the intensive study 
needed for an understanding of the trader's theory. 

58. Corollaries of the law of demand and supply. 

(a) An increase in the supply of a good tends to lower its 
value. 

(b) An increase in the demand tends to raise its value. 

(c) The converse of each of these propositions is also true. 

(d) A change in the value affects both demand and supply. 

References 

Seager, Chapter 6. 

Taussig, Chapter 8-12. 

Ely, Chapter 11. 

Seligman, Chapter 12-14. 

Gide, Pages 40-66; 216-240. 

Smart, Introduction to the Theory of Value. 

Carver, Distribution of Wealth. 



CHAPTER VI 

Value (Concluded) 

59. The producer's theory of value. 

60. Disutility. 

61. Marginal producer. 

62. Varying costs. 

63. Speculation. 

64. Monopoly value.' 

65. Labor theory of value. 

66. Marginal utility. 

67. Marginal consumer. 

68. Consumer's theory of value. 

69. Consumer's surplus. 

70. Marginal utility of money. 

71. Marginal utility affected by supply. 

59. When we study value from the producer's point of view, we 
arrive at a conclusion apparently inconsistent with that reached 
in the preceding chapter. No man will voluntarily undergo the 
pain and sacrifice of production unless he considers that the 
reward will yield an adequate compensation. The producer is 
constantly balancing pain against pleasure, disutility against 
utihty. 

Studying value, then, from the producer's point of view we 
conclude that a good must exchange for at least enough to meet the 
cost of production. 

60. By cost of production is meant the amount of labor and 
sacrifice necessary to bring the commodity to the consumer. 
The pain connected with the production of a good tends to increase 
with the number of units produced. This is known as the law of 
increasing disutility. 

61. The cost of producing a particular commodity is higher to 
some than to others. The man who is barely able to produce 
for sale at the current price is called the marginal producer. If 



24 

the price should drop for any reason, he would be forced out of 
business. 

Assuming that the total supply is to be sold, the value of each unit 
tends to coincide with the cost of the unit produced under the most 
unfavorable circumstances, i.e., with the cost to the marginal pro- 
ducer. For example, if society demands ten units of an article 
it must pay a price satisfactory to the producer of the tenth unit, 
otherwise that unit will not be produced. 

Evidently those who produce at a cost below the margin reap 
large profits. These extraordinary profits are called producer's 
surplus. 

62. Most goods are produced under conditions of varying cost. 
It costs more per bushel to raise seventy bushels of wheat on a 
given acre than to raise twenty bushels; it costs less per auto- 
mobile to manufacture one thousand than it does to manufacture 
ten. 

Commodities are frequently produced at joint cost, as in the 
case of cotton fiber and cotton seed. How is the cost of pro- 
ducing each to be determined? For every five pounds of fiber 
there are usually ten pounds of seed. But the fiber sells for 
twenty times as much per pound as the seed. The breakdown 
of a pure producer's theory is clearly seen here. This theory also 
fails to account for the value of a rare painting, which cannot be 
reproduced. 

63. Speculation also plays a part in determining value. The 
fundamental effect is to steady prices. It tends to make the 
daily market value correspond with the seasonal value; it tends 
to place the seasonal value at such a point as will insure the sale 
of the total supply. By decreasing fluctuations in value specu- 
lation helps business. 

Certain evils arise from speculation to offset the advantages. 
Outsiders, "lambs," enter the market and gamble. The labor 
of speculators is unproductive, in many cases, and predatory. 
The weak usually lose to the strong. This is a social loss since 
the goods lost have a higher utility to the loser than to the one 
who wins. 

64. In all the preceding discussions we have assumed free com- 
petition. But cases of absolutely free competition are rare. 



25 

Sometimes a trade is completely monopolized. The monopolist 
fixes the value of his goods at such a point as will yield the maxi- 
mum net profit. Too high a price will reduce sales. The price 
cannot be dropped below the cost of production. In most trans- 
actions there is a certain element of monopoly and of competi- 
tion. Even an absolute monopolist must face the dangers of 
potential competition and substitution. 

65. Those who think that labor produces all wealth are likely 
to be of the opinion that the value of a good is equal to the labor 
which goes into its production. Rent, interest and profits seem 
to them to be deductions from the just rewards of labor. The 
proposition rests on a false premise — that labor is the sole factor 
in production. 

There are those who say that, while value is not absolutely 
determined by labor, it does vary directly with the amount of 
labor expended in production. This was more nearly true in 
the days of hand manufacture than in the present age of machin- 
ery. We cannot establish a definite ratio between labor and 
value because the contribution of labor varies in the production 
of different goods. We can say that value tends to increase when 
more labor, or natural resources, or capital, or managerial ability 
is used in production and vice versa. But it is well to remember 
that a change in the contribution of one factor may be offset by 
an opposite change in the contribution of another. 

66. There is a school of economists who seek to explain value 
by setting forth the forces of demand alone. They have made a 
valuable contribution towards that intensive study of demand 
which we now find necessary. They have not succeeded in pro- 
ducing a complete explanation of value. 

The consumer's theory is based on the principle of diminishing 
utility. If the consumption of any particular commodity is 
continued indefinitely, the point of satiety will finally be reached. 
The last unit is called the marginal unit. The utility of the 
marginal unit is called the marginal utility of the commodity. 

67. The man who consumes the marginal unit is called the 
marginal consumer. The object has less utility to him than to 
the other consumers and he does not enter the market until the 
others are supplied. If he should, they could easily outbid him 



26 

until their wants were satisfied. If the supply were any less, he 
would not enter the market at all and the utility of the marginal 
unit would be higher. There are certain classes of marginal con- 
sumers for each commodity. There is a certain class for auto- 
mobiles, another for bicycles, etc. 

While one consumer's want may be more intense than that of 
another, he does not pay more than he is forced to for the com- 
modity. In his study of the market he sees that there is a cer- 
tain supply for sale. A further study shows that under the 
existing conditions of demand, if the total supply is to be sold, 
the last unit will have a certain utility far below that which he 
ascribes to the commodity and that the selling price of the last 
unit will be correspondingly low. He immediately resolves to 
stay out of the market until the price falls, knowing that it must 
fall in the end. Other consumers go through a similar process of 
reasoning and resolve to wait. 

68. The result is that each unit of supply, if the whole supply 
is to be disposed of, must he sold at a price approximately equal 
to that of the marginal unit. The value of a commodity is, thus, 
determined by its marginal utility. This is the consumer's theory 
of value. 

In actual practice some may pay a price considerably above the 
marginal price. They may be forced by peculiar circumstances 
to buy at once and, so, may be unable to wait. It is evidently to 
the advantage of the producer to conceal the true state of the 
supply and throw it on the market "piece-meal." In this way 
various marginal utilities will appear to be established and buyers 
will be led to pay higher prices. To throw all the supply out at 
once is to demoralize the market and establish, once for all, the 
actual marginal value in the eyes of the whole world. These 
considerations show how values may vary from the margin. 
They do not invalidate the principle laid down above but tend 
to strengthen it. Marginal utility appears, after all, to be a 
fundamental determinator of value. 

69. Suppose that A, who is willing to pay two dollars if neces- 
sary for a bushel of wheat, succeeds in buying his wheat at one 
dollar. He evidently gets a greater amount of satisfaction for 
his dollar than does the man who is originally willing to pay only 



27 

one dollar. This additional satisfaction is called consumer's 
surplus. 

70. The varying degrees of utility of the money or purchasing 
power of buyers must also be considered. A and B may have 
exactly the same need for an automobile. If A is wealthier than 
B he will be willing to pay more because the marginal utility oL 
money is less to him. This throws an additional complexity into 
the question of value. 

Sellers should try to market their goods so as to take advantage 
of differences in wealth among buyers as well as differences in 
utility of the commodity to be sold. Salt has a fairly uniform 
utility to rich and poor alike. To take advantage of differences 
in wealth it may be placed in pasteboard boxes for sale to the 
rich; in cloth bags for the next in wealth; in bulk, to be weighed 
over the counter, for the poor; and in carload lots for street car 
companies, for use in melting ice from the tracks. 

71. No doubt, it has been noted that marginal utility is not 
independent but is, itself, dependent upon supply. If • the 
supply is increased the marginal utility is lowered and vice versa. 
After all, the forces of supply, as well as those of demand, must 
be studied before the question of value is understood. Neither 
can stand alone as an explanation of market value. 

References 

Seager, Chapter 7. 

Taussig, Chapter 13-16. 

Ely, Chapter 12. 

Seligman, Chapter 15-17. 

Van Antwerp, The Stock Exchange from Within. 



CHAPTER VII 

Money and Credit 

72. Definition and functions of money. 

73. Kinds of money. 

74. Legal tender and lawful money. 

75. Demand for money. 

76. Supply of money. 

77. Nature of credit. 

78. Kinds of credit. 

79. Supply of credit. 

80. Relation of money and credit to prices 

a — Demand and supply theory of money. 

b — Hoarding, barter, credit of limited acceptability. 

72. Any medium of exchange which is universally accepted in 
payment is money. Money is said to perform four functions, as 
follows: medium of exchange, standard of value, standard of 
deferred payments and store of value. The first is the funda- 
mental service of money; the others are secondary to and de- 
pendent upon it. 

73. There are three kinds of money: commodity money, credit 
money, and fiat money. 

Commodity money is money the value of which is approxi- 
mately equal to the value of the material contained in it. Free 
and unlimited coinage is essential. Gold is an example. 

Credit which acquires a sufficiently wide range of accepta- 
bility as a medium of exchange is called credit money. National 
bank notes are one kind of credit money within the United States. 

Fiat money is money the value of which is independent 
of credit and of the material contained in it; but depends upon 
supply and demand. Its supply is regulated arbitrarily by the 
one who issues it. We now have no fiat money in the United 
States. 

74. A careful distinction should be made between legal tender 
and lawful money. The former is any money which the law 



29 

requires creditors to accept in payment of debt. The latter is 
money which national banks are permitted to count as part of 
their required reserves. Gold certificates are lawful money but 
not legal tender. 

75. The demand for money arises out of the need for it as a 
medium of exchange. The total demand for money at a given 
time is measured by the volume of exchanges being effected by 
the use of money plus the quantity of money which is being held 
in store for use in future exchanges. 

76. The supply of commodity money is determined by the 
amount of metal which is mined and brought to the mint. It 
is not perfectly controlled by cost of production because of the 
aleatory nature of mining. Mining is gradually being placed 
upon a more scientific basis but the element of chance must al- 
ways remain in some degree. 

The supply of credit money may be arbitrarily limited as in 
the case of greenbacks; it may be artificially limited as in the 
case of the national bank notes; or it may be automatically regu- 
lated by the natural rules governing the supply of credit. 

The supply of fiat money is always arbitrarily controlled. 

77. Credit is a promise to pay. It is used in purchasing goods, 
services, etc. Since the thing promised is usually money, we 
may define credit, for all practical purposes, as a promise to pay 
money. A promise to pay money which is written, printed, or 
put in any tangible form is called a credit instrument. 

78. Credit may be divided into two classes according to the 
range of acceptability. Credit of general acceptability is com- 
monly used as a medium of exchange throughout a wide terri- 
tory and is known as credit money. 

Credit of limited acceptabihty is accepted only within a small 
area or by a certain number of people. Checks, promissory 
notes, etc., are examples of the latter class. 

79. The supply of credit is governed by various forces. The 
supply which any one person is able to originate depends upon 
his reputation for honesty and ability to meet obligations as 
they come due. The latter in turn is dependent upon his wealth 
and business ability. Business ability, ability to make money, 
is largely influenced by general business conditions. The credit 



30 

supply of the whole world is dependent upon the total number 
of exchanges effected by credit. A good body of business law 
and business information tends to increase the use of credit. 

The amount of credit which will take a particular form de- 
pends upon the customs of the people. In the United States 
much of the credit takes the form of bank deposits; in France 
bank notes are more commonly used. Book credit may be used 
in one country while promissory notes are used in another. 

80. The value of money, like the value of anything else, is 
determined by supply and demand. Price is the exchange ratio 
between goods and money. Price is the reciprocal to the value 
of money. A fall in the, value of money means a rise in prices 
and vice versa. Prices tend to rise when the supply of money is 
increased; or when the existing supply is used more effectively, 
i. e., when the rate of turn-over is increased. They tend to fall 
when the number of exchanges, in which money is used, increases. 

Hoarding decreases the supply of money and so lowers prices. 
Barter decreases the number of exchanges in which money is 
needed and so raises prices. Credit of limited acceptability acts 
as a substitute for money and so raises prices. 

References 

Seager, Chapter 19. 

Taussig, Chapter 17-23. 

Ely, Chapter 14-15. 

Seligman, Chapter 28-30. 

Gide, Pages 283-330. 

J. F. Johnson, Money and Currency. 

Kemmerer, Money and Credit Instruments. 

Laughlin, The Principles of Money. 

Scott, Money and Banking. 



CHAPTER VIII 

Banking and Exchange 

81. Definition and functions of a bank. 

82. Loans and discounts. 

83. Deposits. 

84. Circulating notes. 

85. Domestic exchange. 

86. New York exchange. 

87. Limit to shipment of money. 

88. Foreign exchanges. 

81. A bank is an institution which buys and sells credit. 

The three customary functions of a bank are usually described 
under the heads of discount, deposit and issue. The first and 
second are essential functions; the third is incidental but so 
important as to be classed among the primary functions. 

82. When a bank makes a loan or discount it exchanges its 
money or its own credit for the credit of an individual. If the 
exchange takes the form of a loan, the entire principal is ad- 
vanced in the beginning and interest is paid later. If the ex- 
change takes the form of a discount, only part of the principal is 
advanced in the beginning, the interest charge being deducted 
at the outset and called discount. Competition fixes the rate 
of discount somewhat below the rate of interest. Loans and 
discounts are merged in the bank statement as they are essentially 
the same in nature. The amount of loans which a bank can 
make depends both upon the amount of credit which it can ex- 
tend and upon the demand for loans. 

Collateral loans are loans made against some kind of collateral 
which is deposited as security. Call loans are payable on de- 
mand and the rate of interest fluctuates from day to day with the 
market rate. The rate on time loans is fixed in advance. 

83. Deposits are of two kinds, special and general. In the 
case of the special deposit the bank agrees to return the specific 



32 

thing deposited. The title to a general deposit passes to the 
bank, which agrees to pay back, not the specific thing deposited, 
but an equivalent sum of money. 

There are two chief sources of general deposits. Money or 
"cash items," such as checks, sight drafts, and other clearing 
house items, may be deposited; or, the deposit may be made 
from the proceeds of a loan. Loans and discounts are the chief 
source of deposits. This accounts for the close correspondence 
between the items of loans and discounts and deposits on a bank 
balance sheet. 

84. Bank credit may be advanced in the form of circulating 
notes. A bank note is a promise of the bank to pay a specified 
sum of money to the bearer on demand. It is a liability of essen- 
tially the same nature as the deposit. The principal difference 
is that the note has a wider circulation and can more readily be 
used in making payments to people who are at a distance from 
the bank, or who do not know the financial standing of the per- 
son making the payment. Largely because of this fact note issue 
has been regulated by law more strictly than the business of 
deposit. The proportion of bank credit which will take the 
form of deposits or of notes depends upon the customs of the 
people. Deposits take the form of checks for purpose of circu- 
lation but the life of a check is short. Checks are sometimes 
called deposit currency. Elasticity and swift and certain re- 
demption are the most desirable features of circulating notes. 

85. Payments between individuals in the same community 
may conveniently be made by check or by money. When pay- 
ments are to be made by persons of one community to those of 
another the matter is hardly as simple. Money may be sent 
but risk and expense are involved. Checks may be used but 
they are inconvenient because of the trouble and expense of col- 
lection. The bank draft is more convenient than either checks 
or money. A debtor can arrange with this bank for a draft on 
another bank with which his creditor does business. But it is 
obviously impracticable for each bank to have an account with 
every other bank in the country or with even one bank in every 
other community. It is desirable that an arrangement be made 
by which drafts can be drawn upon the banks of some central 



33 

community and accepted by banks all over the country. The 
banks can establish accounts with some bank in the central 
city. 

86. New York is the financial center of the United States. It 
did not become so by arbitrary agreement among the bankers of 
the country but its financial importance is due to its commercial 
importance. People in every community are constantly buying 
from and selling to New York. Bankers are always ready to 
buy drafts on New York banks because they are constantly in 
need of credit in that city against which they can draw. 

The supply of exchange on New York arises from goods sold 
and to be paid for by exchange on New York; the demand 
comes from people who have bought goods and must make 
remittances. If more goods are bought than are sold the de- 
mand for exchange outruns the supply and exchange goes to a 
premium. The converse is true. The premium or discount can 
not go beyond the cost of shipping money to or from New York. 

87. Money cannot indefinitely move in one direction because 
of the disturbance in prices and interest rates. Prices rise and 
interest rates fall in the community to which money is flowing 
and, as a result, its sales drop and it begins to lend in other com- 
munities. The opposite happens in the other community and 
equilibrium is restored. For this reason a community cannot be 
totally drained of its money supply. Sales and purchases approx- 
imately balance in the long run. 

88. The same principles apply to exchange between different 
countries. London is the financial center of the world. Pay- 
ments between all countries are customarily made by use of Lon- 
don exchange. The draft on London is called a bill of exchange. 

Foreign exchange is complicated somewhat by the difference 
in monetary units in various countries and by the fact that gold 
is the only money that can be paid except in the case of debts to 
a silver standard country. The points, at which exportation or 
importation of gold begins, are called the gold points. The mat- 
ter is further complicated when payment is to be made between 
countries having different monetary standards. There is no 
fixed par of exchange between a country having the gold standard, 
like the United States, and one with the silver standard, as China. 



34 

The import and export points naturally fluctuate along with vari- 
ations in the par of exchange. 

References 

Seager, Chapter 20-21. 

Taussig, Chapter 24-35. 

Ely, Chapter 16-17. 

Sehgman, Chapter 31-32. 

Gide, Pages 330-451. 

White, Money and Banking. 

J. F. Johnson, Money and Currency. 

Escher, Elements of Foreign Exchange. 

Conant, Principles of Banking. 

Tate's Modern Cambist. 

Publications of the National Monetary Commission. 



CHAPTER IX 

Interest 

89. Channels of distribution. 

90. Definition of interest. 

91. How the rate of interest is determined. 

92. Supply of capital. 

93. Impatience theory of interest. 

94. Demand for capital. 

95. Productivity theory of interest. 

96. Differences in the rate. 

97. The commodity rate. 

89. The income of society is distributed through four channels 
to the factors in production. Interest goes to capital, wages to 
labor, rent to land, and profits to the entrepreneur. 

90. Interest is the share of new wealth which capital receives. 
If the owner chooses to use his own capital, that part of his 
income which results from the use of the capital is interest. 
We usually think of interest as a payment for the use of loanable 
funds. The question of interest is raised in our minds only 
when capital is loaned for a consideration. If there were no 
lending there would still be interest. Interest is usually ex- 
pressed in terms of a percentage on the capital employed or 
loaned. 

91. The rate of interest is determined by the interaction of 
the supply of and the demand for capital. An intensive study 
of supply and demand is necessary to an understanding of the 
interest rate. 

92. Capital is the result of saving. Every owner of capital 
would like to consume it at once instead of using it in production 
or lending it to another. In either case, enjoyment of the goods 
is postponed. Evidently the owner must be compensated. Now 
some persons feel the sacrifice much more than others and demand 
correspondingly higher reward. Some are willing to save for 
almost nothing. The same principles are involved whether the 



36 

owner uses the capital himself or loans it to another. He will 
loan it only if he can get a higher return in that way — allowing 
for risk, trouble of management, etc. Every man is willing to 
accept any return above his minimum. 

93. If one hundred units of capital are desired the interest 
must be enough to compensate the man who saves the hundredth 
unit — whose impatience to consume is greatest. If one hundred 
one units are desired, the reward will have to be raised enough to 
warrant the saving of one more unit. The first ninety-nine or 
hundred, as the case may be, will demand as much as the last, 
knowing that they can get it. 

Then, it appears that the interest rate, at a given time, is just 
enough to compensate the marginal saver of capital. This is some- 
times called the impatience or exchange theory of interest, A 
present good is exchanged for a future good. 

This theory succeeds in explaining why lenders demand an 
interest payment; it even indicates what the interest rate will be 
under given conditions of demand. But demand is not static. 
The impatience theory fails to explain why borrowers are willing 
to pay interest; it fails to indicate how much they are willing to 
pay. It is necessary, therefore, to look into the demand side of 
the interest question. 

94. The demand for capital comes from men who wish to use 
it in production. Some borrowers are willing to pay a higher 
rate than others because some discover richer fields of production. 
No man will pay a rate above the yield which he expects to re- 
ceive from his capital; every man will pay, if necessary, any 
rate below his maximum. The man whose maximum is lowest 
and who is barely able to borrow under existing conditions of 
supply is called the marginal borrower. 

Capital, like land, is subject to the law of diminishing returns. 
Each industry is supposedly organized so as to employ land, 
labor and capital in just the right proportions. Additional 
capital will not yield as high a return as the first. As more 
and more capital is saved and put into business new fields 
must be found for its use. The tendency is thus for new 
capital to find less advantageous employment than that found 
by preceding supplies of capital. This partially accounts for 



37 

the comparatively low yield of capital in old and highly de- 
veloped countries. 

The penny-weighing machines in New York City may be 
cited as an example of this tendency. If more machines were 
made it would be necessary to place them in less desirable 
locations. The additional capital would yield a lower return. 

95. The rate by all borrowers, at a given time, will approxi- 
mate the rate which the marginal borrower is willing to pay. 
By a similar course of reasoning we arrive at the conclusion that 
the rate of interest, at a given time, approximates the yield of the 
least productive unit of capital — sometimes called the marginal 
productivity of capital. This is known as the productivity 
theory of interest. It rests upon the truth that capital actually 
produces its own return. 

Keeping this theory in mind, now suppose that the psychology 
of the people changes so that they are willing to save at a smaller 
return. Or, suppose the means of production improves so that 
more can be saved under the same psychological conditions 
because of the increased wealth of the people. The supply of 
capital is increased. It is evident that new borrowers are able 
to enter the market, less productive enterprises are able to attract 
capital, the marginal productivity of capital is lowered and the 
interest rate pushed down. 

It appears that both supply and demand must be considered 
before an adequate explanation of the interest question can be 
reached. 

96. Differences in risk cause the interest rate in specific cases 
to vary from the normal. Monopoly may disturb the market 
at times. The rate is higher in newly settled communities 
because both the risk and the prospective returns are higher. 
The supply is limited. Capital is not perfectly mobile. Rates 
vary also on different kinds of loans in the same community and 
on the same kind of loans to different persons. 

97. The term "commodity rate" is used to express the change 
in purchasing power which the capital returned has in comparison 
to that which was originally loaned. For a loan of $100 for one 
year at 6 per cent interest, $106 will be returned. If the level of 
prices has risen 6 per cent in the meanwhile, the $106 will buy 



38 

no more goods than the $100 would have bought a year before. 
The commodity rate is in this case zero. When prices are rising 
the commodity rate is lower than the nominal rate; when prices 
are falling the commodity rate is the higher. 

References 

Seager, Chapter 16. 

Taussig, Chapter 38-41, 46. 

Ely, Chapter 24. 

Seligman, Chapter 25. 

Gide, Pages 551-571, 733-756. 

J. F. Johnson, Money and Currency, Chapter 7. 

Carver, The Distribution of Wealth, Chapter 6. 

Fisher, The Nature of Capital and Income, and The Rate of 

Interest. 
Bohm-Bawerk, Positive Theory of Capital. 



CHAPTER X 

Wages 

98. Definition of wages. 

99. Real and money wages. 

100. Wages fund theory. 

101. Subsistence theory. 

102. Productivity theory. 

103. Supply and demand. 

104. The monopoly element. 

105. Differences in wages. 

98. Wages are the payment of the services of labor. The pay 
of every laborer, from the lowest menial to the highest salaried 
man, is included in the term. 

99. It is necessary to distinguish between real wages and 
money wages. Wages are usually paid in money but a laborer's 
real wages are what the money will buy. Hence when prices 
are going up, if money wages are not also advancing, real wages 
are declining. On the other hand, a fall in the prices of those 
goods which laborers buy means a rise of real wages, if money 
wages are stationary. 

100. The Wages Fund Theory is a name given to the explana- 
tion of wages worked out by the English Classical School of 
Political Economy. The theory was even reduced to mathemati- 
cal terms, as follows: Capital divided by working population 
equals the rate of wages. Evidently any increase in capital or 
decrease in the number of wage earners raises wages according 
to this theory. 

The theory is based on the following propositions: (1) Indus- 
try is limited by capital and always tends to come up to the 
limit; (2) capital seeks constant employment; (3) the demand for 
labor comes from capital not from consumers of labor's product. 

These propositions are, in the main, true but John Stuart Mill, 
the great advocate of the wages fund theory, himself admitted 
that the theory does not offer a complete explanation of wages. 



40 

The wages fund theory fails to take into account that capital 
itself is a productive agency. There is a constant competition 
between machines and men. A larger percentage of capital 
goes into machinery in one industry than in another. An in- 
crease in the efficiency of labor tends to draw a larger proportion 
of capital funds into wages and vice versa. A given increase in 
the supply of capital cannot by any means be taken to indicate 
a proportionate increase in wages. 

Furthermore the amount of capital in a country at any time 
is not a fixed unchanging sum. It varies with the rate of interest, 
a higher rate encouraging saving, a lower rate discouraging it. 

The wages fund theory more nearly approximated the truth 
before the introduction of modern machinery. 

101. The English economists of the first quarter of the nine- 
teenth century advanced the subsistence theory of wages as a 
corollary of the Malthusian doctrine of population. David 
Ricardo said : "The natural price of labor is that price which is 
necessary to enable laborers, one with another, to subsist and to 
perpetuate their race, without either increase or diminution." 
If wages fall below the minimum of subsistence there will be 
fewer laborers and wages must rise again in the long run. On 
the other hand, if wages go above the minimum for a while, 
there will be an increase in the labor supply and a necessary fall 
in wages again. 

Socialists have made much of this theory as proof that the 
condition of labor cannot be . bettered under the capitalistic 
regime and some have styled it the "iron law of wages." This 
theory is still widely held among the rank and file of labor in 
England. It is based upon an incorrect interpretation of the 
Malthusian doctrine. Malthus did not think that the number 
of laborers must automatically increase as rapidly as the means 
of subsistence. He recognized the fact that the laborer is likely 
to see the disadvantages of too large a family. The volitional 
control of the birth rate is of itself enough to emancipate labor 
from the so-called "iron law of wages." 

The minimum of subsistence sets the lower limit of wages. 
It does not set the upper limit under existing conditions and there 
is no visible evidence that it will in the future. 



41 

102. The productivity theory is the one now most generally 
accepted by economists. Briefly stated it is: Wages tend to equal 
the discounted marginal productivity of labor. 

The terms "discount" and "marginal" need explanation. 
The product of labor is not marketed until some time after wages 
are paid. This accounts for the discount. Some employers of 
labor operate under less favorable circumstances than others and 
are less able to pay high wages. The wages of a group approxi- 
mate those paid by the marginal employer. 

The productivity of labor is measured by the selling price of 
goods less the share which must be paid to land, capital and the 
entrepreneur in order to secure the aid of these factors in the 
process of production. The share of labor cannot be gauged 
accurately but under free competition the distribution must be 
approximately fair. Every employer is constantly endeavoring 
properly to coordinate the various factors in production. Labor 
thus tends to assume its reasonable importance. 

103. In summary, it may be said that wages in any occupa- 
tion tend toward the point where the supply of that kind of labor 
and the demand for it are in equilibrium. The demand for 
labor is, in the last analysis, a demand for the products of labor. 
In supply, labor is similar to the most perishable commodity. 
A laborer must work to live. Higher standards of living, labor 
unions and better education tend to increase the ability of labor 
to hold itself back from the market and demand a higher price 
for its services. 

Labor, like capital, is subject to the law of diminishing 
returns. At a given tim.e there is employment for a certain 
amount of labor at the prevailing rate of wages. Additional 
labor must be content with a smaller reward and it also tends 
to pull down the wages of that labor which is already employed. 

104. Under monopolistic conditions, and a certain element of 
monopoly enters into almost every wage contract, wages may 
vary from the norm that would prevail under free competition. 
The element of monopoly is now on the side of capital, now on 
that of labor. Immobility is one cause of labor's disadvantage 
in many cases. On the other hand, capital is not perfectly 
mobile. The capital invested in a railroad cannot be withdrawn 



42 

or allowed to lie idle while the employers dicker with labor. 
Monopoly in capital is being met by monopoly in labor. Under 
free competition almost all the differences in wages could be 
explained by the unequal capacities of workmen. Poor choice 
of occupation, opportunities and similar factors help to account 
for those differences unaccounted for by variations in native 
ability. The tendency toward uniform wages seen in certain 
groups, especially those organized in labor unions, has its objec- 
tionable side. Employers are prevented from employing any 
labor below a certain standard of efficiency; high grade labor is 
paid only the standard wage and initiative is discouraged. 

References 

Seager, Chapter 15. 

Taussig, Chapter 47, 48 and 51. 

Ely, Chapter, 22. 

Seligman, Chapter 26. 

Gide, Pages 572-656. 

John Stuart Mill, Political Economy. 

Bullock, Selected Readings in Economics, Chapter 18. 

Schoenhof, The Economy of High Wages. 

Thompson, The Theory of Wages and Its Application. 



CHAPTER XI 

Rent 

106. Definition of rent. 

107. Source of rent. 

108. Ricardian theory of rent. 

109. Differences in location. 

110. Capitalization of rent. 

111. Unearned increment. 

112. Supply of land. 

113. The Malthusian doctrine. 

106. Rent is a payment for the use of land. The term has a 
broader application in everyday speech, as "the rent of a build- 
ing." Rent is here confused with interest. Some economists 
are accustomed to c^.nsider fences and other kinds of capital 
goods, which have been more or less permanently affixed to the 
land, as being land itself. It is well to make the distinction, 
whenever possible between capital and interest, on the one 
hand, and land and rent, on the other. We shall see from the 
following discussion that the income from land is governed in 
part by laws very different from those which govern the income 
from other production goods, the reason for this being that the 
supply of land is limited. 

107. Various tracts of land differ in fertility. Men settle 
first on the most productive soil, other things being equal. As 
population increases this soil is tilled more intensively. I'inally, 
the law of diminishing returns makes it profitable to settle^on 
the next poorer grade of soil rather than carry intensive cultiva- 
tion any further on the best soil. The process goes on, each 
poorer grade of land being settled in succession, until all the 
land is in use. The last land to be brought under cultivation at 
a given time may be called the marginal land. 

No rent is paid for any length of time for the use of marginal 
land. If an attempt were made to charge rent the tenant would 



44 

simply move on the next poorer land. After all the land is set- 
tled rent may be charged on the marginal land for a short time. 
But cultivation on this land soon becomes more intensive, returns 
diminish until they are barely sufficient to reward the capital 
and labor on the land, and rent must stop. 

108. Other things being equal, the rent on any land above the 
margin tends to equal the difference between the productivity of the 
land in question and that of the marginal land. This is the 
Ricardian theory of agricultural rent. It assumes free competi- 
tion. 

109. But differences in location, as well as in fertility, may 
cause differences in productivity. Poor land near a market may 
yield a more valuable product than the most fertile land located 
in some inaccessible spot. Differences in site affect the produc- 
tivity of agricultural land and, so, affect the rent. 

Land is needed for building sites, for standing room, as well 
as for agricultural purposes. It is here that differences in loca- 
tion have the greatest effect. 

Theoretically each piece of land is put to the use for which it 
is best fitted. Moreover, it is having applied to it just the right 
amount of labor and capital. Urban land is subject to the law 
of diminishing returns, just as agriculturgjl land is. Taking 
these things for granted we may say that the r^nt of a given piece 
of land is measured by the difference between the value of the products 
obtained from it by the use of the most profitabue amount of labor 
and capital and the value of the products which co'uld be obtained by 
the use of the right amount of labor and capital on marginal land. 
The term ''economic productivity" is used to indicate the value 
of +he product; it depends upon fertility of soil, location ?.nd 
demaiM for the particular products of the land under considera- 
tion. ' 

The above proposition would be true under a condition of free 
competition and perfect adjustment. Actually it is a mere 
tendency. But it is a valuable basis for an analysis of particular 
cases. 

It should be noted that rent is not a factor in determining 
price. Wheat raised on high rent land sells at the same price 
as wheat raised on low rent land. The price of wheat is deter- 



45 

mined by the demand and supply of wheat and is independent 
of rent. Rent is, itself, caused by differences in the economic 
productivity of various pieces of land; and economic produc- 
tivity is equal to price times the quantity of the product. Rent 
is thus partially the result of price and not at all its cause. 

110. The value of land is governed to a great extent by its 
rental. The rent is ''capitalized." A man who demands 5 per 
cent for his money will pay $100,000 for a piece of land that rents 
for $5,000 per year. He will pay even more if he thinks that 
the rent is likely to increase in the future. 

111. An increase in the value of land which comes through 
social forces without any effort of the owner is called an unearned 
increment. Some think that society should appropriate this 
increase in value which is created by itself. There is likely to be 
a certain unearned increment in the value of anything. The 
increment to urban land seems to be about the only one the 
appropriation of which would be practicable under present 
conditions. 

112. The total supply of land is fixed and so would appear to 
have no effect upon rent. But not all of the land has yet been 
pressed into service. As the demand increases new land is occu- 
pied, the margin is lowered, and rent is increased. After all the 
land has been brought into use, rent may be still further increased 
by more intensive use of the better land. 

113. Robert Malthus, one of the early Enghsh economists, 
believed the population must inevitably increase, forcing people 
to occupy poorer and poorer land until the minimum of subsist- 
ence is reached. According to him, population tends to increase 
faster than the means of subsistence. If this tendency is un- 
checked, poverty must be the goal of the race. The increase in 
population is checked by war, pestilence, volitional control of 
the birth rate, etc. 

So far, the means of subsistence seem to have more than kept 
pace with the increase in population, thanks to the opening up 
of new continents and the great improvements in methods of 
production. The land must ultimately be taken up. No fertile 
continents remain undiscovered. Whether continued improve- 
ments will be able to maintain present standards of living remains 



46 

to be seen. Much depends upon a sane exercise of moral restraint 
upon the birth rate. 

References 

Seager, Chapter 14. 

Taussig, Chapter 42-44. 

Ely, Chapter 21. 

Seligman, Chapter 24. 

Gide, Pages 497-550. 

A. S. Johnson, Rent in Modern Economic Theory. 

Carver, Distribution of Wealth, Chapter 5. 

Hurd, Principles of City Land Values. 

Malthus, The Theory of Population. 

Bonar, Malthus. 



CHAPTER XII 

Profits 

114. Definition of profits. 

115. Source of profits. 

116. Competitive profits. 

a — Entrepreneur's wage, 
b — Speculative gains. 
c — Chance gains, 
d — Gains in bargaining, 
e — Business ability 

117. Monopoly profits. 

a — Checks to monopoly profits, 
b — Methods of concealing monopoly profits, 
c — Effect of monopoly profits upon interest, wages and 
rent. 

114. Profits are the excess of the total money income which 
an entrepreneur receives after the shares of land, labor and capital 
have been deducted. Competitive profits are all such profits 
which are not the result of monopolistic control. Monopoly 
profits are those secured by virtue of monopoly control. 
f:::: 115. Profits result from all the many forces which bring about 
differences between the prices of goods and the expenses of pro- 
ducing them. Most important and obvious among these forces 
are: Entrepreneur's wages, speculative gains, chance gains, 
gains in bargaining and monopoly gains. 

116. Let us first discuss the chief elements in competitive 
profits. The entrepreneur's wage is often called the wages of 
management. It is determined just as wages are and there would 
be no serious objection to classing it as wages. To some,' it seems 
worth while to make the distinction because the work of the 
entrepreneur consists to such an extent in coordinating the other 
factors in production. Some economists eliminate the wages of 
management from consideration in the discussion of profits. If 
included they constitute the minimum below which profits can- 



48 

not go. The average entrepreneur will hire to another and so 
join the ranks of wage earners as soon as it becomes evident that 
his wages as such will exceed his profits as an entrepreneur. 

(b) Speculative gains constitute a large element in profits. 
The most successful business men are those who are able to specu- 
late with reasonable accuracy upon the future conditions of sup- 
ply and demand. Every business man is, or tries to be, a specu- 
lator. By calculating the demand of society in advance these 
speculators are able to regulate the supply accordingly and thus 
maintain prices at a normal. Moreover, they produce for con- 
sumers the things which are wanted. These are two valuable 
services. 

(c) Chance gains form an important part of some fortunes. 
In the long run, however, chance losses probably about balance 
the gains when all industries are taken into consideration. The 
European War increased the profits of American wheat farmers 
and inflicted heavy losses upon American cotton growers. 
Weather conditions, unexpected changes in supply and demand, 
etc., affect the profits of almost every business. 

(d) Shrewd bargaining swells the profits of entrepreneurs. 
They are often able to sell at a price above what they would be 
willing to accept and they often cut the expenses of production 
below what they could afford to pay. Entrepreneurs are usu- 
ally at an advantage when bargaining with labor. Skillful bar- 
gaining also reduces the cost of capital and raw materials. 

(e) Differences in business ability largely account for differ- 
ences in profits. Two men in the same business, with equal 
opportunities, will make very different profits. One farmer, by 
good choice of seeds, proper rotation of crops and skillful 
marketing, etc., will grow rich on a farm where another would 
starve. 

These competitive profits depend upon the managerial ability, 
foresight, bargaining skill and good fortune of the entrepreneurs. 
Exceptional profits in any one field attract competition until 
they are lowered. Entrepreneurs thus are constantly on the 
alert for new fields to exploit. Good will sometimes imparts a 
certain degree of permanency to the profits of a business even 
though they be large but good will is a monopolistic element or 



49 

at least an evidence of imperfection in the machinery of com- 
petition. 

117. We now come to the consideration of monopoly profits. 
Monopoly, in economics, usually means such control over the 
market of a commodity, or of labor, as enables the monopolist 
to regulate its price or wage. Sometimes the demand is con- 
trolled but such cases are comparatively rare. The usual mo- 
nopoly results from control of the supply. The monopolist tries 
to regulate supply so as to secure the highest profit in the long 
run. Monopoly profits naturally tend to rise above the profits 
of free competition. 

(a) The chief checks to monopoly profits are: (1) potential 
competition, (2) substitution by consumers, and (3) the fear of 
legal interference. 

(b) To avoid these checks as far as possible monopolists often 
try to conceal their profits from the public. Various methods 
are used such as stock watering, inflating salaries and other ex- 
penses and building up huge surpluses. 

(c) Monopolies tend to reduce the proportion of income which 
goes to interest, rent and wages. If the demand is constant, the 
monopolist's way of securing higher prices is by limiting supply 
below what it would be under free competition. In this way 
production is curtailed and less labor, land and capital is in de- 
mand. A skillful monopolist may stimulate demand above what 
it would be under competitive conditions and thus create a de- 
mand for more land, labor, and capital. But the proportion of 
income going to these factors will in any case be smaller under 
monopolistic conditions than under conditions of free competition. 

References 

Seager, Chapter 12, 13. 

Taussig, Chapter 45, 49, 50. 

Ely, Chapter 25. 

Sehgman, Chapter 23. 

Gide, Pages 657-692. 

Fetter, Principles of Economics, Chapter 31, 33. 

Veblen, Theory of Business Enterprise, Chapter 3. 



CHAPTER XIII 

Value, Price and Distribution 

118. Value and price. 

119. Rent. 

120. Wages. 

121. Interest. 

122. Productivity theory of distribution. i 

123. Population. 

124. Growth of capital. 

125. Conclusion. 

118. Value, price and distribution are closely interrelated in 
the industrial scheme. We may now point out some of the pecu- 
liarities of each factor which most effectively work in the ultimate 
determination of economic relations. 

Goods are valued by units according to their marginal utilities. 
Exchange valuation is a collective, not an individual process. 
The marginal consumer in each group largely sets the valuation 
for all in his class. 

Prices are not determined by expenses of production. It might 
better be said that expenses of production are determined by 
prices, although this statement is not wholly true. Limitation 
of supply together with the operation of demand determine prices. 

119. Rent is a differential payment for the use of natural re- 
sources, caused by differences in the importance of different 
pieces of land in the economic scale. 

120. Wages are paid to labor for its service in production. 
Wages, like rent, are determined by comparisons with the margin 
when competition is free. The marginal wage is fixed by com- 
petition with the other factors in production. Differences are 
due primarily to differences in productive capacity, although not 
entirely. 

121. Interest is a payment for the use of capital and is fixed 
by conditions of supply and demand. Capital supply tends to 



51 

vary with the reward of capital. Demand tends to vary with 
the productivity of capital. 

122. In general it may be said that each factor in production 
tends to receive a reward commensurate with its contribution 
to production. This is sometimes known as the productivity 
theory of distribution. It must be clearly understood that it 
is applicable only to conditions of free competition. Moreover 
it should be remembered that social use valuations play an 
important part in all questions of value, price or distribution. 
Indeed, it is often said that the balancing of utilities and disutili- 
ties in industrial society is the ultimate determinant of distribu- 
tion. In actual life the balance is never reached but the constant 
seeking after the balance is largely accountable for the economic 
actions and relations of men. 

123. The Malthusian doctrine of population has had a strong 
influence upon the economic thought of the last century and is 
still a factor to be reckoned with. Growth of population has an 
important effect upon the standard of living and is itself affected 
by it. On the whole the standard of living has been rising. 
There seems to be a general tendency for the birth rate and the 
death rate to fall off in the western world. The hope of the eugen- 
ists is that population may be made to grow at the top, instead 
of at the bottom. 

124. There is evidence that capital has been increasing more 
rapidly than population. This should result in an improvement 
in the condition of labor through rendering it relatively more 
scarce. 

125. So far we have sought to explain the present system of 
distribution, not to justify it. Even if each factor in production 
should receive its contribution as a reward, the division might 
still be unfair. Men may not have equal opportunities for de- 
veloping their productive powers. Finally, the whole system of 
private ownership in land and capital is thought by some to be 
wrong. These questions of justice or of expediency are relegated 
to later discussions. 



52 

References 

Seager, Chapters 11, 17, 18. 

Taussig, Chapters 52, 53, 54. 

Ely, Chapters 19, 20. 

Seligman, Chapter 4. 

Gide, Pages 451-473. 

Mayo-Smith, Statistics and Sociology; Statistics and Economics. 

Bohm-Bawerk, The Ultimate Standard of Value (Annals of the 

American Academy of Political and Social Science, Vol. V., 

pp. 149-208). 
Carver, The Distribution of Wealth. 
Overberg, La classe sociale. 



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